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In addition to the article below, you can also listen to the above interview with Nazmeera Moola on her budget preview.

By Nazmeera Moola, co-Head of Fixed Income, Investec Asset Management

During the Medium Term Budget Policy Statement, Finance Minister Pravin Gordhan paved the way for significant fiscal consolidation in the coming financial year. In total, National Treasury proposed that spending be cut by R20 billion and taxes raised by R28 billion, amounting to a R48 billion contraction in the 2017/2018 fiscal budget.

On the face of it, this tightening is enormous and represents almost a percentage point of GDP. The question is whether it will be enough to achieve debt consolidation. Since 2009, we have consistently fallen short of our debt consolidation path, with the timing of the peak in the debt-to-GDP ratio repeatedly being pushed out. This needs to stop.

The necessary condition is a primary surplus on South Africa’s main budget. A primary surplus occurs when revenues exceed spending (but excludes interest paid on government debt). Simply put, it would mean that we stop borrowing to make interest payments, which would ultimately stabilise SA’s debt to GDP ratio. This makes our debt sustainable in the long term.

The problem, however, is that growth is weak. Gordhan faces a tough balancing act between raising taxes to increase revenue while maintaining what growth there is. Raise taxes too much, and he runs the risk of stifling growth, which will impact the revenue raised.

A taxing issue

The three major sources of tax revenue in South Africa are personal income tax, corporate income tax and VAT.

Given South Africa’s income inequality, it is tempting to suggest that Gordhan should tax the high-income earners more. However, the last set of SARS Tax statistics from the 2015/2016 fiscal year indicate that only 12% of personal income tax payers accounted for 62% of personal income tax receipts. While it is a reflection of the skewed income distribution in South Africa, it also demonstrates how narrow the tax base is. The ability to raise taxes significantly here is limited.

It is also important to note that this 12% represents middle-income earners, who are struggling with significant increases in school fees, electricity prices and medical aid tariffs. A further point to note is that raising tax brackets for those earning above R1.5million per annum – while on the face of it an attractive proposal – is not going to raise meaningful additional revenue.

In terms of corporate income tax, there is no scope to raise taxes. Internationally, the trend is for corporate tax rates to come down, not go up. South African corporate revenue is also very concentrated, with just 325 companies contributing 58% of corporate tax collections. Moreover, South Africa is at a point where private fixed investment is contracting, so we need to do everything in our power to remain competitive and attract investment.Raising VAT would be a very unpopular move, so it is unlikely that we would see an adjustment here.

What Gordhan will be left with is a solution whereby a selection of smaller taxes are cobbled together to raise the needed R28billion. These could include a sugar tax (probably still premature given that hearings have not yet been concluded), a fuel tax, very limited adjustment for inflation in the tax brackets and a dividend withholding tax.

Cutting costs

Removing R20 billion out of expenditure is going to mean budgets cuts across the board. There has been a huge bloating in bureaucracy across a number of government ministries in recent years, with little improvement in productivity. It would send a very good signal if staff numbers in these underperforming ministries were trimmed down – particularly at the senior levels.

The silver lining

Gordhan will present his budget against a macroeconomic backdrop showing tentative signs of improvement. Growth is likely to pick up this year due to two factors – firstly, a more benign global environment has already seen commodity prices improving and secondly, we can look forward to a much better agricultural harvest. Iron ore prices have more than doubled in the last twelve months. Grain forecasts suggest that South Africa’s maize harvest should surge from 7.5million tons in 2016 to at least 12million tons in 2017. What South Africa really needs, however, is a local policy and regulatory framework that promotes investment. That would make the pick-up in growth sustainable rather than just a cyclical improvement.